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Friday, February 27, 2009

The Case For and Against Bank Nationalizationhttp://www.rgemonitor.com/roubini-monitor/255740/the_case_for_and_against_bank_nationalizationMatthew Richardson | Feb 26, 2009

Secretary Geithner’s financial plan calls for stress tests at the large complex financial institutions (LCFIs). These tests are due to start this week. They will involve estimates on the eventual losses due to default on a wide variety of assets.

Economic analysts have already performed such a test at the aggregate level. It was not a pretty picture. For example, Goldman Sachs looked at the U.S. banking sector’s holdings of the current “toxic” pool of assets, such as option ARM residential mortgages, subprime residential mortgages, Alt-A residential mortgages, credit card debt, second liens/home equity loans, consumer auto loans, and commercial real estate. Expected losses come in at around $900 billion. These losses give the banking sector very little wiggle room. Therefore, there is the real possibility that some LCFIs are bankrupt - the face value of the liabilities exceed the current value of their assets.

I. Insolvent Financial Institutions

If a bank is insolvent, there are three general ways to attack the problem.

The first is unbridled free market capitalism. I am sympathetic to this view. I wish we somehow could figure out a way to let the market work and let these institutions fend for themselves. Shareholders, creditors and counterparties knew the risks they were getting into. After all, why is some debt secured, why do we have collateralized lending, why do riskier assets deserve larger haircuts, etc…? But when Lehman Brothers went down, we looked into the abyss. This would be the equivalent of nuclear armageddon for the financial system.

The second is to provide government aid to the insolvent bank, to in effect throw good money after bad. This is sanctioning private profit taking with socialized risk. Since October of this past year, the government has followed this strategy. Let the banks plod along, throwing money here and there to keep them afloat, at usually way below market prices at a high cost to taxpayers.

It is not a totally crazy solution. There may well be a positive externality to spending taxpayer money to save a few so we can save the entire system. For economists specializing in the field of banking, however, this approach has a familiar ring. In Japan’s lost decade of the 90’s, Japanese banks kept loaning funds to bankrupt firms so as not to writedown their own losses, which resulted in the government supporting zombie banks supporting zombie firms.

As an example, consider the poster child for the “freebie” programs, the Temporary Liquidity Guarantee Program, started in late November of 2008. For a cost of 0.75%, it allows banks to issue bonds backed by the government, i.e., essentially risk free. The banks have accessed this market 97 times for $190 billion!

In terms of helping us move forward out of the financial crisis, this program has many problems. It charges the same amount for each institution, so it hardly separates the solvent from the insolvent institutions. It charges a fee which is grossly below what these institutions could issue in the marketplace given their current balance sheets, distorting the system. Wasn’t this the Fannie Mae and Freddie Mac problem? And it makes it less likely to cleanse the system of the toxic assets because these institutions can continue their way out-of-the-money option and hope that the prices of the toxic assets increase. In effect, the access to this capital allows them to continue to make the original bet.

The final way of addressing insolvency is nationalization. Over the past week, there has been debate about whether nationalization is the right word. According to a standard dictionary definition, it is the act of transferring ownership from the private sector to the public sector. Although this is literally what we are talking about here with certain banks, almost everyone agrees that the type of nationalization that would take place would be a temporary one. Thus, if everything went as planned, a better analogy would be of the government acting as a trustee in a receivership of the bank.

That said, I do think a term like nationalization is the appropriate description. It is a misnomer to think, as a number of pundits have suggested, that we have experience at nationalizing banks through the FDIC. For example, the latest bank (and 39th of the current crisis) to be closed by regulators is the Silver Falls Bank of Silverton, Oregon. It has three branches and assets of approximately $131 million.

It goes without saying that Silver Falls Bank is no Citigroup, Bank of America, Wells Fargo, or JP Morgan, among others. The complexity, size and systemic nature of these institutions deserve deep analysis.

The basic argument for nationalization is that we need an organization to simultaneously facilitate the reorganization of the LCFI and be a trustworthy counterparty to all the current and ongoing transactions. The only one with the balance sheet right now is Uncle Sam. But make no mistake about it. With nationalization of a LCFI, the government is the owner and the ultimate residual claimant. Once we take down the LCFI, we have crossed the Rubicon. The die is cast and there is no turning back.

II. Pros and Cons of Nationalization

It is therefore important to do it right.

* The good bank, bad bank model. Nationalization one-nil.

In order to have a healthy economy, we need a healthy financial system, and for a healthy financial system we need to cleanse the system of the bad assets. Otherwise, creditworthy firms and institutions will not have access to the needed capital, and will prolong the economic downturn.

This is the primary benefit of nationalization of some of the LCFIs. In receivership, it is much easier to separate the bank’s good assets and bad assets – to divest the firm from its toxic assets and troubled loans. This is because insolvent institutions will never take this action. If they did, it would by construction force them under.

The way it would work is that the healthy assets and most of the bank’s operations would go to the good bank as would the deposits. Some of these deposits are insured, others (e.g., businesses and foreign holdings) are not. But the likelihood is that the good bank is now so well capitalized that there would be no threat of a bank run. The net equity, i.e., assets minus deposits, would be a claim held by the other existing creditors of the bank, namely shareholders, preferred shareholders, short-term debtholders and long-term debtholders.

The goal would be to reprivatize the good bank as soon as possible. After all, the point of the exercise is to create health financial institutions which can start lending again to creditworthy institutions. In almost every successful resolution of financial crises in other countries, this was the path.

Of course, the tricky part of nationalization is the handling of the bad assets. The bad assets would be broken into two types – those that need to be managed such as defaulted loans in which the bank would own the underlying asset, and those that could be held such as securities like the AAA- and subordinated tranches of asset-backed securities. With respect to the former, the government could hire outside distressed investors or create partnerships with outside investors as was done with the Resolution Trust Corporation in the S&L crisis.

Along with the equity of the good bank, these assets would be owned by the existing creditors. The proceeds over time would accrue to the various creditors according to the priority of the claims. Most likely, the existing equity and preferred shares would be wiped out in such an arrangement and the debt would effectively have been swapped into equity in the new structure. Under this scenario, it is quite possible, even likely, that taxpayers would end up paying nothing. This is because, for the LCFIs, these creditors cover well over half the liabilities.

* Systemic Risk. Nationalization one-one.

The problem with the above solution is that it shifts all the risk of the insolvent institution onto the creditors of the LCFI. While this is fair to the extent the creditors were accruing the profits in normal times, it may lead to the “Lehman Brothers problem”, that is, this could create runs throughout the system.

Why did Lehman Brothers cause systemic risk?

Was it the counterparty risk, e.g., fear of being on the other side of interest rate swap, credit default swap, or repo transactions? This fear was well founded. Ask any hedge fund whose hypothecated securities disappeared in Lehman’s U.K. prime brokerage operations. It is pretty clear that the government would have to stand behind any counterparty transaction and publicly commit to this rule. Since most of these are margined and collateralized, however, many of the assets would show up in the good bank.

Or was it the short-term debt? The run on money market funds was directly attributable to the Reserve Primary fund’s holdings of a large amount of short-term Lehman commercial paper. One would presume the same thing would happen here as the short-term debt of all questionable LCFIs would come under pressure. It is highly likely that the government might have to step in.

As compared to the standard LCFI, Lehman had very little long-term debt. To understand whether a collapse in the LCFI’s long-term debt value is systemic, one would have to analyze the concentration of this debt throughout the system. If it is widely held, it is unlikely to have systemic consequences. Of course, it would have profound effects on future financing of these firms.

If the government has to cover the creditors, or at least some of them, what has been gained?

On the positive side, the system will have cleansed itself of the assets.

Moreover, to minimize the cost to taxpayers, it is not clear that the government will have to step in. If the government is completely transparent to the market who is solvent and who isn’t, and the reasons why this is, then the type of uncertainty that surrounded Lehman’s failure may be mitigated. Perhaps, the runs on the equity and debt of banks in September and October 2008 occurred because there was no clear message from the regulator.

That said, actions speak louder than words, and, in a dynamic setting where conditions change rapidly, solvent firms can become insolvent very quickly. While the government needs to do a thorough stress analysis, consistent across all the major banks, to find out the trouble spots, the only definitive way they can prevent a bank run on solvent institutions is to backstop all the creditors of these institutions. Maybe the government can provide a haircut, guaranteeing X% of the debt. In any event, in this case, the creditors of the insolvent institutions would not have to be protected.

* The toxic asset problem. Nationalization two-one.

It has been argued that trying to implement nationalization will be near impossible because we won’t be able to price the hard-to-value, socalled toxic assets. It is actually the opposite. The current problem is that banks don‘t want to sell the assets at the price the market is willing to pay for them. If we were banks, we wouldn’t want to sell them either. As long as the government is providing us free money to continue, why not continue the option? Hope is eternal.

But let’s be real. The banks bought illiquid assets with credit risk using short-term liquid funds to borrow against. For taking these types of risk, the banks got paid a hefty spread. And, in normal times, they raked it in. But there is no free lunch in capital markets. In rare bad times, illiquid, defaultable, assets are going to get greatly impaired. There is no mulligan here. It will be easier to resolve this within a receivership.

To make the point using a real economy analogy, this past Christmas, Saks Fifth Avenue sold their designer lines at a 70% discount. Designer labels and boutique shops on Madison Avenue were up in arms. How could they sell $500 Manolo Blahnik shoes for $150? In this economy, they are $150 shoes.

Moreover, receivership allows one to separate out the assets without having to price them.

* Managing a LCFI. Nationalization two-two.

Does the government have the ability to run a LCFI? In a recent conversation, Myron Scholes told me he was also in favor of nationalization, but as long as it lasts just 10 minutes.

With literally tens of thousands of transactions on their books, who is going to manage a LCFI while it is a government institution, good bank or bad bank? Certainly, no one envisions Barney Frank or Christopher Dodd as the Chief Investment Officers of these firms, but there are many concerns. The government can go and hire professionals as they have done with Fannie Mae, Freddie Mac and A.I.G. But much of the value of a Wall Street firm is in its vast array of intangible, human capital. This labor is incentive driven. How much franchise value will be lost during the nationalization process?

Let’s assume this gets sorted out and the government mirrors employment practices elsewhere at other firms. But then with the government’s protection in receivership, who is to prevent the LCFI from making too many, risky loans. They will have a competitive advantage over solvent, albeit less supported banks. This issue has recently come up with other government supported institutions. Indeed, the argument has been made that A.I.G. and Northern Rock to name just two have undercut their competition by respectively offering overly cheap insurance and mortgages.

* Moral hazard. Nationalization three-two.

There is something unseemly about managed funds buying up the debt of financial institutions under the assumption that these firms are too-big-to-fail. In theory, these funds should be the ones imposing market discipline on the behavior of financial firms, not pushing them to becoming bigger and more unwieldly.

It has been said by many that this is not the time for thinking about moral hazard. I disagree. If we bailout the creditors, then effectively we have guaranteed all debt of future financial institutions. We have implicitly socialized our private financial system.

It is certainly true that we can institute future regulatory reform which tries to quell the behavior of LCFIs. But this will be complex and difficult to implement against the implicit guarantee of too-big-to-fail.

Thus, nationalization resolves the biggest regulatory issue down the road, namely the too-big-too-fail problem of banks that are systemically important. In one fell swoop, because the senior unsecured debtholders of the bank lose when it is nationalized, market discipline comes back to the whole financial sector.

So the large solvent banks will have to change their behavior as well, leading most likely to their own privately and more efficiently run spinoffs and deconsolidation. The reform of systemic risk in the financial system may be easier than we think.

III. Concluding Remark

We are definitely caught between a rock and a hard place. But the question is what can we do if a major bank is insolvent? Sometimes the best way to repair a severely dilapidated house is to knock it down and rebuild it. Ironically, the best hope of maintaining a private banking system may be to nationalize some of its banks. Yes, it is risky. It could go wrong. But it is the surest path to avoid a “lost decade” like Japan.

IV. Case Study: Sweden[1]

Sweden has been cited frequently as a model of “nationalization”. While this is probably an exaggeration, the Swedish model is in many ways a model in terms of the principles it puts forth to handle a financial crisis. Putting aside the obvious fact that Sweden’s economy is much smaller and its financial institutions much less complex, it is a useful exercise to describe some basic facts.

The distribution of assets within the Swedish and U.S. banking system were similar. For example, while Sweden had 500 or so banks, 90% of the assets were concentrated in just six. In the U.S., while there are over 7,500 institutions, the majority of assets are concentrated in the top 15 or so.

Sweden’s credit and real estate boom in the late 1980’s closely mirror the U.S.’s similar boom prior to the current crisis. There was even a similar shadow banking system that developed during these periods – in Sweden, unregulated companies that financed their operations via commercial paper whereas in the U.S., unregulated special purpose vehicles (SPVs) via asset-backed commercial paper (ABCP). When the bubble began to burst, there was also sudden collapses in these markets as a few of these companies and SPVs began to fail.[2] Ultimately, the funding came back to the banks, causing them to have large exposure to the real estate market.

As conditions eroded in 1991, the Swedish government forced banks to writedown their losses and required them to raise more capital, otherwise to be restructured by the government. Of the six largest banks, three – Forsta Sparbanken, Nordbanken and Gota Bank - failed the test. One received funding and the other two, Nordbanken and Gota bank, ended up being nationalized.

These latter two banks had their assets separated into good banks and bad banks. The good banks ended up merging a year later and were sold off to the private sector. The poorly performing loans were placed in the bad banks, respectively named Securum and Retrieva. These banks were managed by asset management companies who were hired to divest the assets of these banks in an orderly manner. (It took around four years.)

The main lessons from Sweden are relevant, however, for the current crisis:

1. Decisive action in terms of evaluating the solvency of the financial institutions. 2. Some form of “nationalization” of the insolvent firms. 3. Separation of these insolvent firms into good and bad ones with the idea of reprivatizing them. 4. The management of the process was delegated to professionals, as opposed to government regulators.

The issue of course is whether the complexity of the institutions affect how these principles should be applied in the current crisis. Complexity alone does not nullify these principles.

Professor Richardson is a contributor to the NYU Stern School of Business project, “Restoring Financial Stability: How to Repair a Failed System”, John Wiley & Sons, March, 2009.[1] Many of the facts here are taken from Tanju Yoralmuzer’s piece, “Lessons from the Resolution of the Swedish Financial Crisis.”[2] In Sweden, in September 1990, a finance company called Nyckeln went bankrupt, while in the current crisis, in early August 2007, three ABCP funds run by BNP Paribas halted redemptions, leading to a run on the system.

“IACTA ALEA EST” – the die is cast – said Julius Caesar and crossed the River Rubicon on his way to conquer Rome. That was the end of Roman democracy.

We don’t have a Julius Caesar. But we do have an Avigdor Liberman. When he announced his support the other day for the setting up of a government headed by Binyamin Netanyahu, that was the crossing of his Rubicon.

I hope that this is not the beginning of the end of Israeli democracy.

UNTIL THE last moment, Liberman held the Israeli public in suspense. Will he join Netanyahu? Will he join Tzipi Livni?

Those who participated in the guessing game were divided in their view of Liberman.

Some of them said: Liberman is indeed what he pretends to be: an extreme nationalist racist. His aim is really to turn Israel into a Jewish state cleansed of Arabs – Araberrein, in German. He has only contempt for democracy, both in the country and in his own party, which consists of yesmen and yeswomen devoid of any identity of their own. Like similar parties in the past, it is based on a cult of (his) personality, the worship of brute force, contempt for democracy and disdain for the judicial system. In other countries this is called fascism.

Others say: that is all a façade. Liberman is no Israeli Fuehrer, because he is nothing but a cheat and a cynic. The police investigations against him and his business dealings with Palestinians show him to be a corrupt opportunist. He is also a friend of Tzipi. He cultivates a fascist image in order to pave his way to power. He will sell all his slogans for a piece of government.

The first Liberman would support the setting up of an extreme Right government by Netanyahu. The second Liberman could support a Livni government. For a whole week he juggled the balls. Now he has decided: he is indeed an extreme nationalist racist. As the Americans say: if it walks like a duck and quacks like a duck, it is a duck.

For appearances’ sake he told the President that his proposal to entrust Netanyahu with the setting up of a government applies only to a broad-based coalition encompassing Likud, Kadima and his own party. But that is just a gimmick: probably such a government will not come into being, and the next government will be a coalition of Likud, Liberman, the disciples of Meir Kahane and the religious parties.

SOME ON the Left say: Excellent. The voters will get exactly what they deserve. At long last, there will be an exclusively rightist government.

One of the proponents of this attitude is Gideon Levy, a consistent advocate of peace, democracy and civil equality.

He and those who think like him say: Israel simply has to pass through this phase before it can recover. The Right must get unlimited power to realize its program, without the pretext of being hindered by leftist or centrist members of the coalition. Let them try, in full view of the world, to pursue a policy of war, the overthrow of Hamas in Gaza, the avoidance of any peace negotiations, unfettered settlement, spitting in the face of world public opinion and collision with the United States.

In this view, such a government cannot last for long. The new American administration of Barack Obama will not allow it. The world will boycott it. American Jewry will be shocked. And if Netanyahu strays – even slightly – from the Right and narrow path, his government will fall apart. The Kahanists, up to then his full partners, will divorce him on the spot. After all, the last Netanyahu government was overthrown ten years ago by the extreme right after he sat down with Yasser Arafat and signed an agreement that gave (pro forma) a part of Hebron to the Palestinian Authority.

After the fall of the government, according to this prognosis, the public will understand that there is no rightist option, that the slogans of the Right are nothing but nonsense. Only thus will they arrive at the conclusion that there is no alternative to the path of peace. The voters will elect a government that will end the occupation, clear the way for a free Palestinian state with its capital in East Jerusalem and withdraw to the Green Line borders (with slight, mutually acceptable, adjustments).

For the public to accept this, a shock is needed. The fall of the deep-Right government can supply such a shock. According to a saying attributed (mistakenly, it appears) to Lenin: The worse, the better. Or, put in another way: it must become much worse before it can get any better.

THIS IS a seductive theory. But it is also very frightening.

How can we be sure that the Obama administration will indeed put irresistible pressure on Netanyahu? That is possible. Let’s hope that it happens. But it is not certain at all.

Obama has not yet passed a real test on any issue. It is already clear that there is a marked difference between what he promised in the election campaign and what he is doing in practice. In several matters he is continuing the policies of George Bush with slight alterations. That was, of course, to be expected. But Obama has not yet shown how he would act under real pressure. When Netanyahu mobilizes the full might of the pro-Israel lobby, will Obama surrender, like all preceding presidents?

And world public opinion – how united will it be? How much pressure can it exert? When Netanyahu declares that all criticism of his government is “anti-Semitic” and that every boycott call is an echo of the Nazi slogan “Kauft nicht bei Juden” (“Don’t buy from Jews”) – how many of the critics will stand up to the pressure? How much courage will Merkel, Sarkozy, Berlusconi et al be able to muster? And on the other side: will a world-wide boycott not intensify the paranoia in Israel and push all the Israeli public into the arms of the extreme Right, under the time-worn slogan ”All the World is against us?”

IN THE best of circumstances, if all the pressures materialize and have a maximum impact – how long will it take? What disasters can such a government bring about before the pressure starts to take effect? How many human beings will be killed and injured in attacks and acts of revenge by both sides? Such a government would be dominated by the settlers. How many new settlements will spring up? How many existing settlements will be extended at a hectic pace? And in the meantime, won’t the settlers intensify their harassment of the Palestinian population with the aim of bringing about ethnic cleansing?

The components of the Rightist coalition have already declared that they do not agree to a cease-fire in Gaza because it would consolidate the rule of Hamas there. They seek to renew the Gaza War under an even more brutal leadership, to re-conquer the Strip and to return the settlers there.

Netanyahu’s talk about an “economic peace” is complete nonsense, because no economy can develop under an occupation regime and hundreds of roadblocks. Any peace process – real or virtual – will grind to a halt. The result: the Palestinian authority will collapse. Out of desperation, the West Bank population will turn further towards Hamas, or the Fatah movement will become Hamas 2.

Inside Israel, the government will have to confront the deepening depression and perhaps cause economic chaos. All the sections of the government are united in their hatred of the Supreme Court, and the crazy manipulations of Justice Minister Daniel Friedman will give way to even crazier ones. Under the catchy slogan of “regime change”, targeted assaults against the democratic system will take place.

All these things are possible. One or two years of a Bibi-Liberman-Kahane government can cause irreparable damage to Israel’s standing in the world, Israeli-American relations, the judicial system, Israeli democracy, national morale and national sanity.

THE POSITIVE side of this situation is that the Knesset will once again include a large opposition. Perhaps even an effective opposition.

Kadima came into being as a government party. It will not be easy for it to adapt to the role of opposition. That will require an emotional and intellectual transformation. For ten years I myself conducted an uncompromising oppositional struggle in the Knesset, and I know how difficult it is. But if Kadima manages to undergo such a transformation successfully – which is very doubtful – it may become an effective opposition. The necessity to present a clear alternative to the rightist government may lead it to discover unsuspected strengths within itself. Tzipi Livni’s games with the Palestinians may turn into a serious program for a Two-State solution, a program that will be strengthened and deepened by the daily parliamentary struggle vis-à-vis a government with an opposite program.

Labor, too, will have to undergo a profound transformation. Ehud Barak is certainly not the person to wage an oppositional fight – especially as he will not be the “head of the opposition”, a title officially conferred by law on the leader of the largest opposition faction. He will be second fiddle even in opposition. Labor will have to compete, and perhaps-perhaps this will lead to its recovery. The Bible tells us of the miracle of the dry bones (Ezekiel 37).

That is true even more for Meretz. It will have to compete with both Kadima and Labor to justify its place in the struggle for peace and social recovery.

A real optimist can even hope for the narrowing of the gap between the “Jewish Left” and the “Arab parties”, which the Left has until now boycotted and left out of all coalition calculations. The common struggle and the joint votes in the Knesset may bring about a positive development there too.

And beyond the parliamentary arena, the government of the extreme Right may change the atmosphere in the country and stimulate many well-intentioned people to leave the security of their ivory towers and start a process of intellectual rejuvenation in the circles from which a new, open and different Left must spring.

ALL THESE are theoretical possibilities. What will happen in reality? What will be the consequences of a “pure” rightist regime, if Tzipi Livni maintains her determination not to join a Netanyahu government? Will Israel set off down a suicidal road from which there is no return, or will this be a passing phase before the wake-up call?

It is a great gamble, and like every gamble, it arouses both fear and hope.

Thursday, February 26, 2009

In recent days two high-level assessments of the threats facing the United States have come out, and both are striking for their stark omissions of the same central theme: the criminal/terrorist nexus that is driving so much of what we see around the world.

The first assessment is the Annual Threat Assessment presented by Dennis Cl Blair, the Director of National Intelligence, presented as Congressional testimony.

The second is FBI Director Robert Mueller to the Council on Foreign Relations.

Both are interesting reading, and is heartening to see the Horn of Africa move far up the priority scale in both discussions. The DNI report also focuses some passing (but more than any other public statement) attention on Latin America, particularly Venezuela.

Director Mueller correctly states that: The world in which we live has changed markedly in recent years, from the integration of global markets and the ease of international travel to the rise and the reach of the Internet. But our perception of the world—and our place in it—also has changed...The universe of crime and terrorism stretches out infinitely before us, and we, too, are working to find what we believe to be out there, but cannot always see.

What has changed less, it seems, is the ability to integrate into out thinking and assessments changes as they occur. My full blog is here.

A riptide or rip current is caused after waves coming in from the ocean hit the beach. The receding water is referred to as a backwash, causing a rip current on the surface. The bigger the waves, the more dangerous the riptide becomes to swimmers. In a strong riptide, swimmers are at greater risk of being caught in the backwash. The ultimate consequence is drowning. Riptides occur on the surface and swimmers trapped in them have a chance to survive by relaxing and swimming across the current, parallel to the shoreline. Unfortunately, the natural tendency is to swim against the current directly toward shore. This places the swimmer at higher risk of tiring and drowning, which could be avoided had the swimmer swam across the current and out of the riptide. More harrowing is an undertow. Undertows are currents along the bottom of the backwash. They pull their victims down beneath the surface. A strong undercurrent can knock a swimmer down and drag that individual out to sea on the bottom of the ocean. This makes the risk of drowning far greater.

What is the relevance of this information to financial institutions?

Many financial institutions are currently treading water in an ocean of economic uncertainty. They are having enough trouble staying afloat without having to worry about riptides, or worse yet undercurrents. Regrettably, the waves hitting the banks attempting to stay afloat are growing larger and more violent making it more difficult for those institutions to tread water. Consequently, the resulting riptides and undercurrents are gaining momentum and becoming extremely dangerous.

As the financial crisis has worsened over the last six months, many thousands of bank employees have lost their jobs. As this situation continues to grow bleaker, the layoffs will continue. In addition to the alarming number of layoffs, financial institutions have had to slash budgets dramatically. These overwhelming resource reductions are placing financial institutions at greater risk for falling prey to dangerous riptides or worse, a fatal undertow.

Although financial institutions are being forced to downsize staff and budget because of the losses they are sustaining, it does not relieve them of their Bank Secrecy Act (BSA) compliance and reporting obligations. Many of the people being let go from financial institutions are compliance professionals. The loss of talent and experience, coupled with likely diminished compliance functionality, could well be the next crippling blow causing one or more financial institutions to drown due to a catastrophic compliance breakdown.

The BSA requires financial institutions to establish and maintain a robust anti-money laundering (AML) program. An AML program has four mandatory requirements:

Essentially, financial institutions must have the ability to assess and mitigate risk. They must have the ability to monitor their systems for risk and to establish controls to ensure they meet all BSA reporting requirements, the most important of which are suspicious activity reporting and know your customer policies and procedures. The loss of highly qualified compliance professionals and the potential of decreased monitoring make it extremely challenging for financial institutions to adequately meet their reporting requirements. In many institutions, compliance professionals are not considered revenue generators, only cost centers. Therefore, a mindset could easily exist among senior business executives that compliance professionals are more expendable. This rationale is pervasive in the industry and incredibly flawed.

Compliance professionals may not be revenue generators. However, given the opportunity to perform and meet their obligations, they are revenue savers and/or loss preventers. If financial institution business executives follow their natural instinct and opine to cut compliance professionals because they are merely considered cost centers, then they will find themselves swimming against the riptide and will be more likely to drown in unnecessary business risk.

In today’s monetary crisis, many financial institutions are taking responsible steps to reduce unnecessary overhead. There are a number of internal institutional redundancies, where reductions are justified. This is particularly true where fraud, security and/or AML programs overlap by virtue of having been stove piped or having been duplicated as the result of mergers or acquisitions, resulting in redundant functions. In those instances, compliance resource reductions are generally more justifiable. However, compliance staff reductions must be assessed for the potential risk of inability to adequately meet BSA reporting and monitoring requirements.

The two elements of the AML program mandatory requirements that are most susceptible to budget cuts are training and internal controls. Training budgets have probably been sliced to the bone, as one of the easiest places to cut. How can compliance professionals continue to learn about the nuances of money laundering, emerging trends, and to adequately understand terrorist financing, if they do not receive appropriate training? Likewise, internal controls and monitoring capabilities have likely been reduced to more minimal levels. Any reduction in controls and/or monitoring capabilities place financial institutions at greater risk of vulnerability. How much compliance risk are these institutions willing to accept in order to meet budget reduction demands?

A troubling reality exists. Budget cuts have not escaped the attention of fraudsters, money launderers, and most problematic, terrorist financiers. The best of these bad guys know how to identify systemic weaknesses and exploit them for their nefarious purposes. They must be salivating at the opportunity in front of them.In spite of the massive problems the financial crisis is causing financial institutions, there are two questions they better come to terms with:

1. How far are they willing to cut their compliance programs and risk non-compliance with BSA reporting requirements?2. Do they have a belief that the regulators will give them a pass from BSA reporting requirements because of the perilous position they are already in?

Before answering these questions, financial institutions should come to the realization that they could be swept up in a dangerous riptide or undertow. Will they swim across the tide and reach safety or will they swim against the tide and drown. It will be interesting to see the choices they make as this unprecedented financial crisis plays out.February 26, 2009 03:49 PM

Nuclear OptionsHans Blix, The Guardian Should we be worried? The International Atomic Energy Agency has reported that the Iranians' uranium enrichment programme is proceeding, though perhaps at a slower pace. Iran is not answering questions raised by western intelligence. The IAEA cannot exclude the possibility that the Iranian programme has military aspects. So, yes, there should be concern, but there is even more reason to be distressed that this has been going on for years in full view, yet has not been met with effective diplomacy.

EU Trio Targets Tougher List of Iran SanctionsGuy Dinmore, Najmeh Bozorgmehr, and Alex Barker, Financial Times France, Germany and the UK - the so-called EU3 - are proposing a tough list of additional sanctions to be imposed against Iran in order to give the Obama administration more muscle in its expected engagement of the Islamic republic.

Iran Denies Nuclear Slowdown, Sets Big Expansion Hossein Jaseb, Reuters Iran said on Wednesday it plans a nearly 10-fold expansion of its uranium enrichment capacity in the next five years, denying a U.N. report which said its nuclear activities had slowed.

Syria Says Disputed Site Has MissilesDavid Crawford, The Wall Street Journal A suspected Syrian nuclear site bombed by Israel has been converted to a military installation for firing missiles, a Syrian delegate told diplomats in Vienna at a Tuesday meeting of the United Nations' nuclear watchdog agency.

The IAEA Should Call for a Special Inspection in Syria James Acton, Mark Fitzpatrick, and Pierre Goldschmidt, Proliferation Analysis

When the International Atomic Energy Agency's Board of Governors meets next week, Syria's case will be high on its agenda. Syria is suspected of building, at a site known as Dair Alzour, an undeclared nuclear reactor that was destroyed by an Israeli airstrike in September 2007. The IAEA has found strong evidence to support this accusation but, as yet, no proof. It has repeatedly asked Syria for greater access on a voluntary basis. Syria has repeatedly refused. It is now time for the IAEA to move beyond such voluntary requests and invoke its most powerful inspection provision, the "special inspection," to make its requests for access legally binding. If Syria refuses then the Board should make a formal finding of "non-compliance."

Dramatic changes are needed in order to succeed in Afghanistan and Pakistan. Almost daily, the people of the region experience deteriorating security and a worsening economic situation. At the same time, Afghans and Pakistanis will both be making tough political choices in the coming months, and the United States and major allies are in the midst of multiple policy reviews. The appointment of Ambassador Richard Holbrooke should provide the opportunity to transform the current approach into one that has clear goals and a compelling narrative.

Afghanistan and Pakistan on the Brink is the result of a 200 person conference, held on November 21, 2008 at the Center for Strategic and International Studies (CSIS) and co-organized by the Institute for National Strategic Studies (INSS) at the National Defense University (NDU). The event included participants from all parts of the U.S. government. (See agenda in Appendix A and participants in Appendix B).

The report is divided into three sections: 1) Policy Challenges; 2) Assumptions; and 3) Recommendations and Policy Options.

World Premier of "Return to the Gulag: Jon Utley's Search for His Father" is being broadcast at http://Reason.tv

WASHINGTON, DC- Reason.TV ( http:/reason.tv) is featuring "Return to the Gulag: Jon Utley's Search for his Father" as its film of the week from February 25 to March 2. This is the world premier of the 28-minute documentary, which chronicles the search for one of the millions of men arrested in Russia during Stalin's Reign of Terror in the 1930s.

One can view the film at the home page of Reason.TV, which gets some 1.4 million visitors per month. No special players are necessary to see the broadcast.

" Return to the Gulag" depicts the search for details about the fate of Arcadi Berdichevsky, Jon Utley's father, the chief financial officer of the Soviet Import-Export agency Promexport, who was arrested by secret police at midnight, April 10, 1936. His wife and son never saw him again, and until Jon's trip never knew the reasons for the arrest or the cause of his death.

Arcadi Berdichevsky's experiences serve as a microcosm of the all-engulfing great terror imposed by Stalin "when few were spared ominous fear, paranoia, imprisonment, hard labor, and even death," the film's narrator explains. Arcadi was arrested without cause, tried by a kangaroo court, and sentenced to hard labor in the Gulag, in Vorkuta, Komi, on the Arctic Circle, in northern Russia. This true story was also the fate of some 18-20 million others in the 1930s who were sent to the Soviet Gulag.

Freda Utley, Arcadi's British wife, organized an international campaign for his release which included personal letters to Stalin from prominent international figures. All pleas were ignored. http://www.fredautley.com/

Freda Utley, who was an author, scholar, and British trade union leader, and her son, Jon, went for years not knowing even the charges against Arcadi, nor his whereabouts.

With the collapse of the Soviet Union, Jon Utley, nearly 70 years later, was able to return to Russia and find original files and government photos of his father -- and learn of his surprising death by firing squad in 1938 for leading a hunger strike in the camps.

The documentary includes news and file footage of the life and times of Soviet Russia in the 1930s in addition to interviews with Ann Applebaum, author of Gulag: A History; Joshua Rubenstein of Amnesty International; and Russian archivists and historians.

It was filmed on-site tracing Jon Utley's journey through former labor camps and cities in northern Russia to find the records. "Return to the Gulag" is a small but revealing window into Russia's turbulent 1930's.

"Return to the Gulag" was directed by John J. Michalczyk, Director of Boston College's Jacques Salmanowitz Program for Moral Courage in Documentary Film ( http://www.bc.edu/bc_org/avp/cas/fnart/fil...tz/default.html) which provided funding for the film along with the Freda Utley Foundation.

An article by Jon Utley, " Vorkuta to Perm: Russia's Concentration Camp Museums and my Father's Story" about the subject of the documentary can be seen at http://www.FredaUtley.com.

A longer film on the Soviet concentration camps, "Confronting Amnesia: Frozen Memories of the Soviet Gulag," has also been produced by Boston College.

DVDs of "Return to the Gulag: Jon Utley's Search for his Father" are available for purchase from the Victims of Communism Memorial Foundation , http://www.victimsofcommunism.org for $15 plus shipping. To order, visit the website or send an email to vocmemorial@aol.com.

Tuesday, February 24, 2009

Secretary of State Hillary Clinton will announce at the Gaza donor's conference next week that the US will give $900 million to help rebuild the Gaza Strip. That is about a billion dollars.

It is obvious why Clinton is making this gesture. The United States's name is mud in much of the Muslim world because Washington supported to the hilt Ehud Olmert's brutal assault on the people and civilian infrastructure of the Gaza Strip. Gaza was already a blockaded and abused slum before the war, where 15% of the children were undernourished. Bush urged Olmert on, and Obama has been silent.

So at least the US can spend some money to restore to the Gazans the basic prerequisites for a decent life.

Moreover, the US has increasing competition for influence in the area.The Gulf oil states are planning out the rebuilding of Gaza, and Saudi Arabia and Qatar have already pledged $1.25 billion. Qatar stole thunder in Lebanon last spring when it negotiated a peace deal between Hizbullah and the Lebanese government that brought Hizbullah into the government. The Saudis have been trying to bring Fatah and Hamas together. The US has been irrelevant, because under Bush Washington was just a ventriloquist dummy for the Israeli Rightwing. You can only have leverage as a good faith broker if you aren't completely identified with one side of a dispute.So people are asking where the US government is going to get a billion dollars to give to the Gazans. That's easy. The US should take it out of the over $3 billion a year it gives to Israel. Israel aggressively launched that war, which it planned out for six months beforehand, even while Olmert was ostensibly indirectly negotiating a truce with Hamas. The war was fruitless and accomplished none of its goals. There is no reason for the US government to be giving the Israelis, who have a per capita income of $17,000 a year, money in the first place. But it certainly makes no sense to reward them for bad behavior, especially given that we are living through the great crash and incipient depression of 2009.

Amnesty International is going further and urging that the UN institute a weapons ban on both Israel and the militant Palestinian factions.

A reliable friend and colleague swears that he saw the following incident in the Israeli-occupied territories a couple of years ago. A Palestinian physician, in urgent need of permission to travel, was trying to persuade a soldier at a roadblock to allow him to hurry on to the next town. He first tried the stone-faced guard in Hebrew, in which many Arabs are fluent, but he received no response. He then made an attempt in English, which is something of a local lingua franca, yet he fared no better. After an unpleasant interval of mutual noncommunication, it transpired that the only word the Israeli soldier knew was no, and the only language in which he could speak it was Russian.

The words occupation and dispossession are flung around pretty freely, but I invite you to picture a life under occupation in which your unfriendly neighborhood cop did not even speak the language of the state that he served, let alone any tongue known to you. There is, by the way, a fair likelihood that the soldier was not even Jewish; it's an open secret in Israel that tens of thousands of Russian immigrants used forged papers as a means of exiting their country of birth, pretending to exercise the "right of return." So here is yet another insult to heap on those whose great-great-grandparents were born in Palestine yet are treated as if they live there only on sufferance.

Yet if you are a former bouncer born in former Soviet Moldova, like Avigdor Lieberman, you can come to live in the Holy Land as of right and become the leader of a party that proposes to institute a "loyalty oath" not just to the Arab citizens of the state of Israel but to all Jewish members of religious Orthodox sects that do not declare themselves Zionist. And this grotesque party, named Israel Beiteinu or "Israel Is Our Home," is now the power broker, and its leader is the kingmaker in the Israeli electoral process.

In his early days as an immigrant in Israel, Lieberman was briefly a member of Kach, the hysterical group led by Rabbi Meir Kahane that was morbidly obsessed with the sex lives of Arabs and that yelled for their mass expulsion or—to employ the common euphemism—"transfer." He has now somewhat refined his position, calling for an exchange of territories and people that would more nearly approximate partition or even a two-state solution. But as with every such proposal, this still leaves a large number of Arabs under Israeli sovereignty, either on the West Bank or in Israel "proper." I doubt that Lieberman is really serious about any "land for peace" negotiations—he quarreled even with Ariel Sharon about disengagement from Gaza, so if it were up to him, there would presumably still be Israeli settlers in the strip. He has changed the whole tone of the argument by deciding to question the presence of Israeli Arabs who, unlike their cousins under occupation, enjoy the right of citizenship and voting as well as the privilege of living under the Israeli flag.

The best book about this highly interesting and neglected community was written by the Israeli novelist David Grossman in 1993 and is called Sleeping on a Wire. It contains micro-flashes of illumination (such as the probability that more Israeli Arabs than American Jews speak Hebrew) and also some memorable reflections on language and its relationship to literature and culture. We all remember that Maimonides wrote in fluent Arabic, but it's perhaps less well-known that:

The everyday conversation of Palestinian Israelis sparkles with expressions from the Bible and the Talmud, from Bialik and Rabbi Yehuda Halevy and Agnon. Poet Naim Araideh effuses: "Do you know what it means for me to write in Hebrew? Do you know what it's like to write in the language in which the world was created?"

One might not wish to go that far, but it remains the case that the Israeli-Arab Marxist Emile Habibi, author of the classic novel The Pessoptimist (sometimes called The Opsimist) was once awarded the annual Israeli prize for best Hebrew writing.

One might add that the rockets of Hamas and Hezbollah fall upon these people, too, in Jaffa and other towns, just as they fall upon the Israeli Druze and Armenians. The threads and imbrications that bind and layer the discrepant claimants to the land of Palestine are strong as well as subtle, ancient as well as modern. This is why Grossman was so depressed to discover, at the end of his book, that the memory of 1948 was still vivid among even the most successful and prosperous Israeli Arabs and that all of them felt unsafe and secretly feared a renewal of the demand for their expulsion. In 1993, he felt able to some extent to reassure them about this.

Now we have to watch the rise of a thug and a demagogue who has called with relish for the execution of elected Arab members of Israel's parliament if they meet with Hamas, who has demanded the drowning of Palestinian prisoners in the Dead Sea, whose supporters chant "Death to the Arabs" at their rallies, and who has materialized the worst fears of those Arabs who have made the longest-lasting accommodation with the Jewish state. Avigdor Lieberman's essentially totalitarian and Inquisitionist style, though, may be even more manifest in his insistence that non-Zionist haredim, or pious Jews, also either take an oath of loyalty or forfeit their citizenship. This takes the ax to the root of the idea that Jews have a presence in Jerusalem from time immemorial and that their resulting rights are not derived from, or dependent on, any state or any ideology. Shame on Benjamin Netanyahu if he makes even a temporary alliance with Lieberman. As questionable as the "right to return" may already be, it certainly cannot confer the right to expel.

President Obama is working against time to untangle 30 years of enmity and prevent Iran from building a nuclear bomb, but even his own advisors know the chance of success is slim.

So they also have been working on Plan B: What do we do if Iran gets the bomb?

Today, the Obama administration is debating its Iran policy behind closed doors. Last year, however, four of its key appointees wrote about the issue as private citizens, and their writings suggest they are already planning for how to handle a nuclear Iran.

Dennis Ross, the former Middle East peace negotiator who is expected to be named as Obama's top Iran advisor, argued for giving diplomacy a chance to work but suggested that containment might have to be the future course of U.S. policy."Maybe, even if we engage the Iranians, we will find that however we do so and whatever we try, the engagement simply does not work," Ross wrote in a September report published by the Center for a New American Security, a think tank that has supplied several appointees to the new administration. "We will need to hedge bets and set the stage for alternative policies either designed to prevent Iran from going nuclear or to blunt the impact if they do."

If diplomacy fails, another Obama advisor wrote in the same report, the alternative "is a strategy of containment and punishment." That was the conclusion of Ashton B. Carter, Obama's reported choice as an undersecretary of Defense, who also warned: "The challenge of containing Iranian ambitions and hubris would be as large as containing its nuclear arsenal."

Most (and maybe all) of Obama's advisors see the costs of attacking Iran as outweighing the benefits. If Iran gets closer to acquiring nuclear weapons, they've warned, military action won't look any more appetizing than it did under George W. Bush.

But that doesn't mean the United States would do nothing. Instead, Obama aides suggested in their writings, the U.S. should pursue a Persian Gulf version of the containment strategy used against the Soviet Union during the Cold War. What would that mean? For starters, a nuclear-capable Iran would face continued, serious pressure from the United States and its allies to dismantle whatever it had built. Obama might declare that a nuclear attack on Israel would be treated as an attack on the U.S. homeland. And the U.S. military would act to bolster Iraq, Saudi Arabia and other Persian Gulf states against conventional-warfare threats from an emboldened Iranian regime.

And there is some optimism among administration officials that a nuclear Iran would practice restraint. Gary Samore, Obama's top advisor on nuclear proliferation, and Bruce Riedel, who is running Obama's review of policy on Afghanistan and Pakistan, wrote last year that a nuclear-capable Iran, while undesirable, would not be the end of the world. For example, they argued, it seems unlikely that Tehran would give nuclear weapons to terrorists.

"If Iran acquires nuclear weapons, it is likely to behave like other nuclear weapons states, trying to intimidate its foes, but not recklessly using its weapons," Samore and Riedel wrote in a report for the Brookings Institution and the Council on Foreign Relations. "As such, Iran will be subject to the same deterrence system that other nuclear weapons states have accommodated themselves to since 1945."

None of this thinking means Obama has abandoned hope in negotiations to stop Iran from building nuclear weapons. At this point, one official said, the administration is focusing on Plan A, not Plan B. But it's welcome evidence that behind the slogan of hope lies a realistic appraisal of the possible outcomes.

During his presidential campaign, Obama called the idea of a nuclear Iran "unacceptable," and offered to meet with the Tehran regime without precondition to persuade it to change course. And his advisors agree that there's still a window for diplomacy.

Samore and Riedel forecast that Iran is "at least two or three years away" from being capable of building a nuclear weapon, and note that there are several stages between capability and deploying a bomb -- stages at which the United States could still work to freeze the program and contain Iran's behavior.

The first step, Ross wrote, would be to gather support from Europe, China and Russia. (Undersecretary of State Bill Burns is working on that already.) Next, Obama would seek direct, comprehensive talks with Tehran -- with a tangible threat of tougher economic sanctions if the Iranians don't cooperate, and the promise of rich rewards if they do.

So what should we expect? The contacts with Iran might start with secret talks in Europe between special envoys on both sides, but they're unlikely to begin before Iran's presidential election in June. To pave the way, Obama and his aides have toned down their rhetoric on Iran and talk mostly of outstretched hands and mutual respect. (They are learning to live without the phrase "carrots and sticks," which Iranians say should be used only when talking about donkeys.) Negotiations won't be easy, and they won't be fast. It's not even clear whether the faction-ridden Tehran government will be able to agree on a coherent negotiating position.

Still, Obama has two advantages his predecessor didn't. First, he has sent unambiguous signals that he's ready to talk with Iran and recognize its legitimacy. That gives Tehran no clear reason to walk away, and Russia and China no easy excuse for opposing tougher sanctions.

Second, with oil revenues tanking, Iran's mullahs are likely to be feeling more vulnerable -- perhaps the only silver lining in the global financial crisis. Russia, Iran's biggest arms supplier, and China, Iran's biggest nonmilitary trading partner, will have less to lose from joining in sanctions if Iran is cutting back on foreign purchases.

Ross, Carter, Samore and Riedel all declined to talk last week when asked if they wanted to expand on what they wrote last year. But their work on Iran before they joined the government adds up to this forecast: Negotiations with Iran are worth trying, but they're not likely to succeed.

If talks fail and Iran moves closer to acquiring nuclear weapons, the United States and its allies will have three options: more sanctions, even though they haven't worked; containment, including a stronger security commitment to Israel; or war. And of those three unpalatable choices, containment -- with all its uncertainties -- will look like the middle way.

An article by former Deputy National Security Advisor Elliott Abrams from the Weekly Standard. Not only does Abrams put the entire burden on the Palestinians shoulders for building institutions, he also asks zero positive moves from the Israelis (absolutely no mention of settlements or Jerusalem), and ends the article by arguing against a Palestinian state, suggesting instead control by Egypt and Jordan. He also takes a swipe at Annapolis and, implicitly, Condi Rice.

The Path of Realism or the Path of FailureLaying a foundation for peace in Palestine.by Elliott Abrams03/02/2009, Volume 014, Issue 23

Repetition of failed experiments is not a sign of mental health or apath to scientific progress, nor is it a formula forIsraeli-Palestinian peace. Yet that is the road we may again take,unless the lessons of the Bush years are learned.

As an official of the Bush administration I made three dozen visits tothe Middle East in the last eight years, and in February, as Israelisvoted, I made my first visit as a private citizen in nearly a decade.After lengthy discussions with Israelis and Palestinians, it seems tome obvious that it is time to face certain facts, facts that PresidentBush actually saw clearly during his first term: We are not on theverge of Israeli-Palestinian peace; a Palestinian state cannot comeinto being in the near future; and the focus should be on building theinstitutions that will allow for real Palestinian progress in themedium or longer term.

In a historic speech on June 24, 2002, President Bush said, "My visionis two states, living side by side, in peace and security." How werewe to get there? He was specific:

There is simply no way to achieve that peace until all parties fightterror. Peace requires a new and different Palestinian leadership, sothat a Palestinian state can be born. I call on the Palestinian peopleto elect new leaders, leaders not compromised by terror. I call uponthem to build a practicing democracy based on tolerance and liberty.

If the Palestinian people actively pursue these goals, America and theworld will actively support their efforts. If the Palestinian peoplemeet these goals, they will be able to reach agreement with Israel andEgypt and Jordan on security and other arrangements for independence.And when the Palestinian people have new leaders, new institutions andnew security arrangements with their neighbors, the United States ofAmerica will support the creation of a Palestinian state, whoseborders and certain aspects of its sovereignty will be provisionaluntil resolved as part of a final settlement in the Middle East. . .. A Palestinian state will never be created by terror. It will bebuilt through reform. And reform must be more than cosmetic change ora veiled attempt to preserve the status quo. True reform will requireentirely new political and economic institutions based on democracy,market economics and action against terrorism.

This was the announcement that the United States was breaking totallywith Yasser Arafat--the single most frequent foreign visitor to theClinton White House--and would henceforth consider him a terroristrather than a negotiating partner. Six months later the "Roadmap," aplan for progress toward these goals, was drafted. Even its formalname, "A Performance-Based Roadmap to a Permanent Two-State Solutionto the Israeli-Palestinian Conflict," suggested its conformity toPresident Bush's speech. Its preamble stated in part, "A two-statesolution to the Israeli-Palestinian conflict will only be achievedthrough an end to violence and terrorism, when the Palestinian peoplehave a leadership acting decisively against terror and willing andable to build a practicing democracy based on tolerance and liberty."

The Roadmap did not call for leaping directly from the status quo--thePalestinian Authority, or PA, established after Oslo--to statehood.Instead it called for an interim phase "focused on the option ofcreating an independent Palestinian state with provisional borders andattributes of sovereignty, based on the new constitution, as a waystation to a permanent status settlement." The text here reiteratedthe need for Palestinian leaders "acting decisively against terror,willing and able to build a practicing democracy based on toleranceand liberty."

After Arafat's death in November 2004, his lieutenant Mahmoud Abbasbecame president of the PA, and efforts to achieve some of theserequired reforms began. But there began as well a distancing by theUnited States and the international "Quartet" that had sponsored theRoadmap (the United States, United Nations, European Union, andRussia) from the tough and clear standards that had been set out. Itis as if those standards were meant to record disgust with Arafat, butwith his passing the familiar insistence on rapid progress--and moreIsraeli concessions--returned.

More and more speeches, including American speeches, called for rapidagreement on a Palestinian state, for a final status agreement, forelimination altogether of that interim phase. Worse yet, at theAnnapolis Conference, announced in July 2007 and convened thatNovember, the president announced that the goal was a final statusagreement by the end of 2008. This left only 13 months, which wasitself astonishing for a problem as old and complex as theIsraeli-Palestinian conflict. It seemed to ignore the June 2007 Hamastakeover of Gaza, and, as the end of 2008 coincided with the end ofthe president's own term, it seemed to substitute the Americanpolitical calendar for a realistic assessment of facts on the ground,just as the Clinton administration had done.

And it failed. Those of us within the Bush administration who hadprotested the Annapolis plan and the announcement of the 2008 goalwere sadly proved right. Historians may puzzle over the causes of thefailure, and perhaps more so over what led the president to turn awayfrom the tough-minded realism toward this conflict that he showedduring his first term. But the lesson for 2009, for the newadministration, must be that there are actually only two alternatives:realism and failure.

Judging by the standards set forth in President Bush's stillremarkable 2002 speech, the PA has made some genuine progress. UnderU.S. tutelage, training of Palestinian security forces has begunlargely under the radar, at a training center in Jordan. But it isworking: Sixteen hundred police from the West Bank have gone throughthe course, and there are plans to double that number. The newlytrained forces are not exactly crack troops, but they are a far cryfrom the divided and ineffective gangs created by Yasser Arafat. Theirsuccess was visible during the recent Gaza war, when they acted inparallel, and sometimes in concert, with Israeli forces to preventHamas violence and terrorism in the West Bank. Order was maintained.

Much of the credit goes to PA prime minister Salam Fayyad, aU.S.-trained economist whose integrity, candor, and effectiveadministration of the PA have made him a favorite of the United Statesand all other donors. Fayyad, a former finance minister (who broughtorder from chaos in the PA's finances and continues to fight PAcorruption), has presided over continuing economic growth in the WestBank and maintains a working if unfriendly relationship with Israeliofficials. Fayyad is well aware of the history of his sometimepartner, sometime foe in Jerusalem, the government of Israel, andindeed of the history of the entire Zionist enterprise: Institutionswere built over long decades to prepare for Israel's independencedespite the uncertainty of when it would arrive. The Zionistsstruggled to be ready, hoping thereby also to bring the day closer.That is Fayyad's task for the Palestinian people, as he appears to seeit.

He gets remarkably little help, from either Arab states or the West.The willingness of oil-rich Arab leaders to supply Palestinians withendless amounts of rhetoric and precious little cash is not new,though the high oil prices of recent years made it all the moreobscene. But Fayyad has also had less help from the West than onemight expect. The shift away from realistic efforts to buildPalestinian institutions and toward international conferences likeAnnapolis put President Abbas in the limelight, not the pragmatic workof Fayyad and his ministers. So Abbas traveled from capital tocapital, as he continues to do, safely removed from the difficult workof building the basis for an independent Palestine. If the West Bankhad a factory with a thousand jobs for every such trip, for everyphoto op with a smiling foreign leader, and for every internationalconference, the Palestinians there would be thriving.

What are the chances that such meetings will produce a final statusagreement in 2009? None. Despite the pressures for progress afterAnnapolis, little progress was made in 2008, and if anythingconditions are worse now. In 2008, Israeli-Palestinian negotiationswere frequent at two levels: Prime Minister Ehud Olmert met withPresident Abbas, and Foreign Minister Tzipi Livni met with Palestinianchief negotiators Ahmed Qurei ("Abu Ala") and Saeb Erekat. I amunaware of the achievement of any actual agreement on any importantissue on either track.

On the toughest issues, such as Jerusalem and refugees, there was,unsurprisingly, no meeting of the minds. It is unlikely negotiatorswill do better this year. It has been true for decades that the mostIsrael can offer the Palestinians is quite evidently less than anyPalestinian politician is prepared to accept. Those who say "theoutlines of an agreement are well known" and thereby suggest that anagreement is close are precisely wrong: Is it not evident that to theextent that such outlines are "well known," they are unacceptable toboth sides or they would have led to a deal long ago? In addition, anypossible deal would take years to implement: Israel would need thattime to remove settlers from lands that would become part ofPalestine, while the Palestinians would need to win the fight againstterrorism. So any deal would be a so-called shelf agreement, wherePalestinian leaders would be compromising on Jerusalem, borders, andrefugee claims in exchange not for a state, but for an Israeli promiseof a state at some indeterminate future date. No Palestinian leaderjumped at that in 2007 or 2008, and none will in 2009.

Meanwhile, whatever the strengths and weaknesses of the PA as aninstitution, Fatah as a party is moribund. Its reputation forincompetence and corruption remains what it was when Arafat was alive,for there has been no party reform despite endless promises. At onepoint in 2008, when Ahmed Qurei--one of Arafat's closest cronies,famed for permitting corruption, renowned for opposing the rise of anynewer and younger leaders in Fatah--was formally charged withorganizing and implementing party reform, tragedy gave way to farce.But if democracy is impossible without democratic parties, thecollapse of Fatah is no joke; it suggests that a future independentPalestine would either be run by Hamas and other extremists andterrorists or become a one-party "republic" on the model of Tunisia orEgypt.

There is more. Prime Minister Olmert, who was intent on trying for anagreement by the end of President Bush's term, will be gone, and hissuccessor will not be as enthusiastic to make the concessions Olmertreportedly offered the Palestinians. President Obama has not committedhimself to achieve an agreement in 2009 in the way that President Bushdid in 2007 and 2008. The Palestinian political leadership underPresident Abbas and his Fatah party is weak, even increasinglyillegitimate as the presidential election date prescribed in thePalestinian law was ignored and Abbas's term in office extended. And,of course, it is impossible to see how a comprehensive final statusagreement between Israel and the PA can be reached when the PA itselfhas now lost control of 40 percent of the Palestinian population, the1.4 million Palestinians living in Gaza.

First, there is the question of who can actually negotiate with Israelon behalf of the Palestinian people. The Palestine LiberationOrganization (PLO) is still recognized by the Arab League and theUnited Nations as the "sole legitimate voice of the Palestinianpeople" though it never won a free election to attain that status.Israel's past negotiations, in the Oslo Accords of 1993 and eversince, have all been with the PLO--not formally with the PA, which wascreated at Oslo to exercise certain governmental functions in thePalestinian territories. When Israel negotiates with Abbas, it is inhis capacity as chairman of the PLO, not in his role as president ofthe PA. But now the PA governs only one part of Palestinian territory.Hamas governs the other part--and Hamas is not a member of the PLO. Inthe 2006 elections 44 percent of Palestinians voted for Hamas,moreover, and it maintains a majority in the Palestinian parliament (apossible problem should that body ever meet). So, for whichPalestinians do Abbas, the PA, and the PLO actually speak? WhileIsrael rightly refuses to negotiate with a terrorist group like Hamas,or with the PA or PLO should it include Hamas in its ranks, it remainstrue that the PA and PLO no longer have a strong claim to representall Palestinians and may now lack the ability to enforce any deal withIsrael they sign.

Second, the lesson of Gaza to Israelis is identical to the lesson ofsouth Lebanon, and a cautionary tale regarding withdrawal from theWest Bank: "Land for peace" concessions have failed and become "landfor terrorism." Until there is far better security in the West Bank,few Israelis would risk withdrawing the Israel Defense Forces and ShinBet from operating there.

And third, the terrorist groups Israel is dealing with, such as Hamasand Palestinian Islamic Jihad, used to be local; now those groups havethe full backing of Iran, both directly and through Syria andHezbollah. The Israeli-Palestinian conflict is now part of a broaderstruggle in the region over Iranian extremism and power. Israeliwithdrawals now risk opening the door not only to Palestinianterrorists but to Iranian proxies. How could Israelis, or Palestiniansfor that matter, take such a risk--especially when the new Americanadministration has not defined its policy toward Iran, except for somevague and (to Arabs and Israelis alike) worrying phrases aboutoutreached hands and sitting across negotiating tables, and the U.S.military option is invisible?

Taken together, these factors suggest that a final status agreement isnot now a real-world goal. What is? A return to the realisticassessments and policies that marked Bush's first term. In practice,this suggests an intense concentration on building Palestinianinstitutions in the West Bank.

There is much to build on, with security force improvements well underway, the economy in decent shape, and a reliable and trustworthyleader in Prime Minister Fayyad. Neither the United States nor Israelhas done nearly as much as it can to promote progress on the ground,allowing Palestinians in the West Bank freer movement and helpingcreate more jobs and a better standard of living. After the Gaza war,Israel appears prepared to do more, and should be asked to do so;Israel has a strategic interest in the success of the PalestinianAuthority in the West Bank and of moderate forces in Palestiniansociety more generally. Arab states should be pressured intensely toprovide the funds needed to meet the PA payroll and undertake sensibleinvestment projects, for example in housing and agriculture. TheUnited States and the Quartet should take some time away from endlessmeetings and speeches and resolutions calling for immediatenegotiations over final status issues, and turn instead to making reallife in the West Bank better and more secure. If there is ever to be aPalestinian state, it will be the product of such activities, not offormulaic pronouncements about the need for Palestinian statehood now.

It is also time to rethink the recent commitment to leaping all atonce to full independence for the Palestinians, and even to break thetaboo and rethink that ultimate goal itself. Immediate and totalindependence was not the plan when the Roadmap was written in 2002 andreleased in 2003. Then, it was understood that "an independentPalestinian state with provisional borders and attributes ofsovereignty" was a necessary way-station. Given Hamas control overGaza, which makes a united independent Palestine impossible for nowanyway, a West Bank-only state with provisional borders and only someof the attributes of sovereignty makes far more sense as a medium-termgoal. It might also allow postponing compromises on Jerusalem andrefugee claims that no Palestinian politician could now make, forthose issues could be left aside for another day, while the delays areblamed on Hamas and its rebellion in Gaza.

How that episode will end is entirely unclear, given Israel'sreluctance to reoccupy and rule Gaza, and Egypt's reluctance toenforce strict controls on the smuggling of weapons. One Israeliofficial told me that Egypt had agreed to stop the smuggling throughthe tunnels. But will they really do it? I asked him. Oh, he replied,"now you are asking if we can get an agreement to implement theagreement. That's different." While Iran is able to sustain the Hamasterrorist regime in Gaza, negotiations over a full final statusagreement are little more than staking territorial claims to a mirage.

But one is free to wonder as well whether Palestinian "statehood" isthe best and most sensible goal for Palestinians. When I served underSecretary of State George Shultz in the Reagan administration, we wereexpressly opposed to that outcome and favored some links to Egypt andJordan. On security and economic grounds, such links are no lessreasonable now; indeed, given Hamas control of Gaza and the Iranianthreat to moderate Arab states as well as to Israel, they may be evenmore compelling. As we've seen, President Bush in 2002 stated that thePalestinians should "reach agreement with Israel and Egypt and Jordanon security and other arrangements for independence."

Now, even the mention of Egyptian and Jordanian involvement will evokeloud protests, not least in Amman and Ramallah, and perhaps U.S.policymakers should think but not speak about such an outcome. Thereare many and varied possible relationships between a Palestinianentity in the West Bank and the Hashemite monarchy, and if none can beembraced today, none should be discarded either. One Arab statesmantold me when I asked him about a Jordanian role that there "mustabsolutely be an independent Palestinian state in the West Bank--ifonly for 15 minutes," and then they could decide on some form offederation or at least a Jordanian security role for the area. If thegreatest Israeli, Jordanian, and Egyptian fears are of terrorism,disorder, and Iranian inroads in a Palestinian West Bank state, aJordanian role is a practical means of addressing those fears.

Israel's next government, which Israel's president has asked BenjaminNetanyahu to form, must soon take up these matters with thePalestinians, Arab neighbors, the EU, and above all with the UnitedStates. The new Obama administration has not yet worked out a policytoward Iran or toward the Israel-Palestinian conflict, but that may bea hopeful sign. Thinking is better than assuming or reacting ormisjudging. As the new team reviews the playing field, it would bewell advised to look not only at what its predecessors did in thesecond Bush term, but also at what they did in the first term--when agritty realism prevailed over visions, dreams, and endlessconferences. For, again, it seems to me there are at present only twopaths forward--the path of realism and the path of failure.

Elliott Abrams, senior fellow for the Middle East at the Council onForeign Relations, was a deputy national security adviser in the Bushadministration.

ISRAEL'S next prime minister, Benjamin Netanyahu, will face an earlytest when he finally takes office in the next few weeks: should heditch an election pledge and follow his defence chiefs' strategicadvice to explore a peace treaty with Syria?

During his campaign Netanyahu, the leader of the conservative Likudparty, had struck a belligerent note and pledged he would never agreeto Syria's main demand that the Golan Heights, seized by Israel in the1967 war, should be returned.

On reaching office, however, Netanyahu will be presented with reportscompiled by Mossad, the overseas spy agency, and by militaryintelligence, that strongly advocate opening negotiations withPresident Bashar al-Assad of Syria.

According to sources familiar with the documents, both Amos Yadlin,the head of military intelligence, and Meir Dagan, his Mossadcounterpart, recommend a deal not only to eliminate the risk of warwith Syria but also to create a split between Damascus and Iran,Israel's arch foe.

A United Nations report last week said Iran had accumulated astockpile of more than one ton of low-enriched uranium hexafluoride atits nuclear facility in Natanz. If highly enriched this would beenough for a nuclear weapon.

Intelligence analysts say no Israeli government could accept anuclear-armed Iran. But if it came to a showdown Israel would wantSyria, which has close ties to Iran, to stay neutral. It also wantsSyria to stop supplying arms to Hezbollah, the Islamic political andparamilitary group in Lebanon.

Israel has recently violated Syrian sovereignty on three occasions:with the assassination of Imad Mughniyeh, a Hezbollah leader, inDamascus last February; the killing of a Syrian general, MohammedSuleiman, near the Syrian port of Tartous last August; and a raid onan alleged nuclear facility in September 2007.

The reports argue that Israel is vulnerable to Syria's upgradedchemical weapons capability, which is being expanded with the help ofNorth Korean experts. Satellite images that emerged last week showednew construction work at the heavily protected site of al-Safir.

Netanyahu, who was prime minister from 1996 to 1999, is likely to forma coalition with religious parties and the Yisrael Beiteinu (Israel isOur Home) party, led by Avigdor Lieberman, the secular rightwinger.

Yesterday Senator John Kerry, the former US Democratic presidentialcandidate, visited Assad amid signs that Washington is stepping uppressure on Israel to negotiate a deal.

As prime minister Netanyahu came close to signing an agreement in 1998with Hafez al-Assad, the late Syrian president, in which he agreed togive back the Golan in return for a lasting peace.

"Indeed I did have negotiations with the Syrians," Netanyahu admittedin an interview in 2007. "I told Assad I'd need Mount Hermon [a4,000ft Israeli outpost overlooking Damascus] because I need radar tolook towards Iran, and Assad gave up the mountain. I was surprised andhappy."

Aides close to Netanyahu say an agreement with Syria is the surest wayfor Netanyahu to make political progress with the new administration,as they profoundly disagree on other aspects of a Middle East peacedeal.

"If he achieves a real breakthrough with Syria, he expects theAmericans to give him a break with the Palestinians," said a closeaide of Netanyahu.

At least one rocket fired from Lebanon landed in northern Israelyesterday, wounding three people and prompting Israel to respond withan artillery attack.

Analysts of all political stripes, including, most importantly, members ofthe new U.S. president's foreign policy team, seem to agree that Iran isstriving to build the bomb. Why else would a state risk further economicisolation, or worse, to develop nuclear-related technologies whose outputit could pursue more cheaply and easily on the open market? But as theforeign policy cognoscenti argue the merits of enhanced sanctionspackages, grand bargains, and military options in changing Tehran'sbehavior, it is worth reconsidering the question of whether Iran evenplans to develop nuclear weapons, and how certain anyone outside ofIranian decision-making circles can be of that answer.

The controversial 2007 National Intelligence Estimate, which found thatIran halted its nuclear weapons program four years earlier, appears tohave been all but forgotten. Regardless, more instructive is the inverseof that report's central point; in order to halt a program it must firstexist, a fact that suggests the intelligence community has significantevidence that Tehran, at one point at least, authorized the development ofnuclear weapons.

Beyond the estimate, all that is known publicly is that Iran has a historyof hiding sensitive nuclear sites from the International Atomic EnergyAgency and that Tehran has yet to answer the agency's questions on whatare known as the "alleged studies"--documents said to indicate Iranattempted to develop a ballistic missile re-entry vehicle capable ofcarrying a nuclear warhead. This lack of transparency has fueled thecharges of those who dismiss Tehran's denials of wrongdoing. The IAEA'slatest report is a case in point, revealing that Tehran understated byabout one-third the amount of bomb quality uranium it has enriched,meaning it could very likely produce a bomb with current stocks if itchose.

Still, probably more important to most observers than uncertainintelligence and games of cat and mouse is simple logic; all experts agreethat Iran's desire to enrich uranium to produce nuclear fuel makes littlesense from an economic or energy perspective. Russia has agreed to provideenriched uranium for Iran's only existing, and not yet operational, powerplant, and fuel for any future plants could be similarly acquired on theopen market. Indeed, the EU-led overtures to Iran have included suchguarantees. Moreover, Iran's efforts to produce this fuel are not onlypremature but are costly and inefficient, wiping away the economicbenefits Tehran supposedly hopes to reap by developing nuclear powerplants in the first place. Adding the negative economic and politicalconsequences of sanctions to the mix only makes Iran's nuclear policy moresenseless unless the program is meant as a cover or hedge for weaponsdevelopment.

As tempting as it may be to accept such wisdom, the West's experience inassessing the motives behind Iraq's behavior under sanctions should givepause; sometimes actions that appear irrational--say, enduring cripplingeconomic sanctions and inviting a war to uphold the veneer of a WMDcapability--have a rationale that is unrecognizable to outsiders. It wasnot tales of mobile biological labs and mistaken assessments of aluminumtubes that led to the Bush administration's excessive confidence in Iraq'sguilt--although these collection and analytic lapses certainly did nothelp. Rather, it was a gut feeling that Iraq's intransigence, and itsensuing costs and risks, only made sense if Baghdad was harboring weaponsit felt it needed to ensure its survival. In reality, Saddam did view suchweapons as vital, so much so that his regime risked everything to maintainthe mirage it still possessed them. While Saddam's calculation waswrong--in fact the ploy brought on the outcome he hoped it wouldprevent--the thinking at least becomes understandable when viewed from theIraqi perspective.

Similarly, an unexpected reasoning might exist for Iran's seeminglyself-destructive behavior today. Investing in nuclear technology forenergy production does make some sense for Iran, a country with a growingpopulation that imports more than 40 percent of its refined petroleum.Diversifying its energy needs also could, in theory at least, free upcrude oil for Iran to export. After all, no credible analyst isquestioning the United Arab Emirates' motives in seeking nuclear plants,despite ranking sixth worldwide in proven oil reserves. Citing Iran'smassive reserves to prove the absurdity of an Iranian nuclear energyprogram is therefore pointless.

There may even be a legitimate motive behind Iran's dogged pursuit of adomestic enrichment capability, a much more alarming policy. While it istrue that the West has offered fuel guarantees that would negate the needfor a costly enrichment program, Tehran would have reason to doubt thesanctity of such promises. The nuclear dispute is but one of many areas ofcontention between Iran and the West, and it would not be unreasonable forTehran to expect nuclear-related deals to dissipate in the event of futureflare-ups involving Hezbollah. Given how sanctions have crippled otherimportant industries in Iran, why leave something as essential as energyproduction vulnerable to outside suppliers?

"It might be worth spending a bit of time contemplating whether theunbearable outcome the West is desperately trying to prevent even existsas an option in the minds of Iranian decision-makers."

Domestic politics also should not be dismissed as a driver of Tehran'snuclear policy. Iran remains autocratic, but even its recent electionresults support the maxim that all politics is local. Although it would befoolish to grant them too much credibility, most published poll resultsshow that a large majority of Iranians support the nuclear program and areopposed to compromise. The issue appears to have become one of nationalpride, with the ordinary Iranian, regardless of his or her opinion of theruling regime, viewing Western efforts to constrain its nucleardevelopment as hypocritical at best and malicious at worst. The alreadyunpopular mullahs could fear further backlash if they were seen asabandoning technological development because of outside pressure. It wouldbe short-sighted to expect Iranian leaders to share the West's assumptionsthat its promises are reliable, and raw domestic political calculationscould have a greater influence over Iranian policymaking than genericconcerns about the country's overall economic health.

The lack of any serious debate on the question of Iran's intentions issomewhat stunning, given that the United States remains mired in a warcaused in part by the failure to accurately forecast Iraq's weaponscapabilities. President Bush himself has expressed disappointment at hisadministration's failures regarding the Iraqi WMD case, and the U.S.intelligence community, judging by the tone of the 2007 NIE, appears to besimilarly chastened. All the more surprising then that outside analysts,even those opposed to the more hawkish options being floated to deal withthe problem, appear willing to assume the worst when it comes to Iran'sintentions.

The consequences of a deepening rift with Iran are unknown but scary--anunleashed Hezbollah, further Iranian meddling in Iraq and Afghanistan,potential missile attacks against U.S. allies in the region, andskyrocketing oil prices. Some observers believe that if Iran acquired anuclear "guarantee" it would become even more mischievous than it is todayand for that reason alone the country must not be allowed to cross thenuclear threshold. Others argue that whatever plans Tehran now has for itsnuclear program are irrelevant, since intentions are subject to change. Insuch a view, capabilities are all that matter. But before risking suchcostly consequences, it might be worth spending a bit of timecontemplating whether the unbearable outcome the West is desperatelytrying to prevent even exists as an option in the minds of Iraniandecision-makers.

The writer is the National Intelligence Fellow at the Council on ForeignRelations.

While President Obama signed orders to deploy 17,000 additional U.S.troops to Afghanistan, including 8,000 Marines, his thinking on theAfghan war has changed significantly. It's no longer the gung-ho viewof a surge-type operation routing al Qaeda's terrorists.

The reinforcements also fall shy of the 30,000 troops requested byGen. David McKiernan, the commander of U.S. forces in Afghanistan,which would have doubled current U.S. force levels in a country of 35million the size of France. Juggling troop requirements between twowars leaves one theater shortchanged. "Even with these additionalforces," warned Gen. McKiernan, "I have to tell you that 2009 is goingto be a tough year."

Al Qaeda is in the Federally Administered Tribal Areas (FATA), thoseseven tribal agencies under Pakistani sovereignty on the Afghanborder, not in Afghanistan. But the more the United States keepsbombing al Qaeda's safe havens in FATA by remote-controlled, unmannedPredators, the more civilians get killed, and the more Taliban'spolitico-religious fanatics boost their stock in Pakistan proper.

Mr. Obama faced his first foreign hurdle on open-ended NATOcommitments in Afghanistan when he made his first foreign visit toCanada this week. But when the moment of truth arrived, he punted. "Icertainly did not press the prime minister on any additionalcommitments beyond the ones that have already been made," he saidlater.

The Canadian Parliament had already voted to pull out its 2,800troops by 2011, and both Prime Minister Stephen Harper and ForeignMinister Lawrence Cannon made clear only another vote in a hostileParliament could change that.

The only other two nations authorized to fight in Afghanistan -Britain and the Netherlands - are also under parliamentary pressure towrap up their kinetic contributions by the end of 2011.

Centcom commander Gen. David H. Petraeus believes the British willstick it out with the United States as long as it takes. PrimeMinister Gordon Brown's entourage does not share Gen. Petraeus'confidence.

President Obama is also asking the other NATO allies with kineticallyimpaired troops whose parliaments voted to keep them out of harm'sway, to contribute more soldiers. France, Germany and Spain havedeclined. Italy, under conservative leader Silvio Berlusconi, hasagreed to boost its Afghan contingent from 2,300 troops to 2,800. Theyare based near Herat close to the Iranian border and will only beallowed to open fire against Taliban if the G-8 summit of majorindustrial nations next July, on the island of La Maddalena, betweenCorsica and Sardinia, agrees. Not exactly an Italian call to action.

President Obama's main Afghan concern now is to avoid going intonegotiations with "moderate" Taliban elements from a position ofweakness. In an interview with the Canadian Broadcasting Corp. priorto his one-day visit to Ottawa, Mr. Obama indicated a shift in hisAfghan strategy when he made clear diplomacy will now play a biggerrole in U.S. efforts in Afghanistan. "I am absolutely convinced," thepresident explained, "that you cannot solve the problem ofAfghanistan, the Taliban, the spread of extremism in that regionsolely through military means. ... We're going to have to usediplomacy. We're going to have to use development."

An immediate worry is the ability to defend Kabul, the Afghancapital, with NATO troops that are not authorized to fight. The first3,000 U.S. reinforcements will be deployed around the city to thwartTaliban's plans to stage a Tet-type offensive, which was when VietCong guerrillas infiltrated major Vietnamese cities in 1968. Eventhough defeated, the Viet Cong scored a major psychological victorythat demoralized America's home front.

President Hamid Karzai keeps complaining about U.S. troops he saysare turning the population against them by breaking into homes lookingfor Taliban guns and ammo, and killing any civilian who resists. "Theywill get plenty of flowers and gratitude when we send them safely backhome," Mr. Karzai opined sarcastically.

After reading up on Afghan briefing papers, Mr. Obama concludedDefense Secretary Robert Gates was only partly correct when he said"there needs to be a three- to five-year plan for re-establishingcontrol in certain areas, providing security for the population, goingafter al Qaeda, preventing establishment of terrorism, betterperformance in terms of delivery of services to the people." Thistends to co-mingle Taliban and al Qaeda. For Mr. Obama, they are twoseparate entities and the split should be encouraged.

When they take place, negotiations will be with Taliban, not with alQaeda. As for the $32 billion in U.S. economic aid to rebuild thecountry, there are still major cities with only two hours ofelectricity daily. But there are still powerful elements, bothcivilian and military, adamantly opposed to negotiations. They saythat we should be prepared to stick it out another 10 years ifnecessary.

But are the American people willing to go along? And doesn't thecurrent financial and economic upheaval put a bit of a crimp ongrandiloquent expressions of open-ended bravura? The next big debatewill be about Taliban "reconcilable."

Arnaud de Borchgrave is editor at large for The Washington Times andfor United Press International.